Financial Statements - Microsoft Corporation (MSFT)

Year: 2020

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INCOME STATEMENTS

(In millions, except per share amounts)


Year Ended June 30,	2020		2019		2018

Revenue:
Product	$	68,041	$	66,069	$	64,497
Service and other		74,974		59,774		45,863


Total revenue		143,015		125,843		110,360


Cost of revenue:
Product		16,017		16,273		15,420
Service and other		30,061		26,637		22,933


Total cost of revenue		46,078		42,910		38,353


Gross margin		96,937		82,933		72,007
Research and development		19,269		16,876		14,726
Sales and marketing		19,598		18,213		17,469
General and administrative		5,111		4,885		4,754


Operating income		52,959		42,959		35,058
Other income, net		77		729		1,416


Income before income taxes		53,036		43,688		36,474
Provision for income taxes		8,755		4,448		19,903


Net income	$	44,281	$	39,240	$	16,571


Earnings per share:
Basic	$	5.82	$	5.11	$	2.15
Diluted	$	5.76	$	5.06	$	2.13

Weighted average shares outstanding:
Basic		7,610		7,673		7,700
Diluted		7,683		7,753		7,794

Refer to accompanying notes.

PART II

Item 8

COMPREHENSIVE INCOME STATEMENTS

(In millions)


Year Ended June 30,	2020			2019			2018

Net income	$	44,281		$	39,240		$	16,571


Other comprehensive income (loss), net of tax:
Net change related to derivatives		(38	)		(173	)		39
Net change related to investments		3,990			2,405			(2,717	)
Translation adjustments and other		(426	)		(318	)		(178	)


Other comprehensive income (loss)		3,526			1,914			(2,856	)


Comprehensive income	$	47,807		$	41,154		$	13,715

Refer to accompanying notes.

PART II

Item 8

BALANCE SHEETS

(In millions)


June 30,	2020		2019

Assets
Current assets:
Cash and cash equivalents	$	13,576	$	11,356
Short-term investments		122,951		122,463


Total cash, cash equivalents, and short-term investments		136,527		133,819
Accounts receivable, net of allowance for doubtful accounts of $788 and $411		32,011		29,524
Inventories		1,895		2,063
Other current assets		11,482		10,146


Total current assets		181,915		175,552
Property and equipment, net of accumulated depreciation of $43,197 and $35,330		44,151		36,477
Operating lease right-of-use assets		8,753		7,379
Equity investments		2,965		2,649
Goodwill		43,351		42,026
Intangible assets, net		7,038		7,750
Other long-term assets		13,138		14,723


Total assets	$	301,311	$	286,556


Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	12,530	$	9,382
Current portion of long-term debt		3,749		5,516
Accrued compensation		7,874		6,830
Short-term income taxes		2,130		5,665
Short-term unearned revenue		36,000		32,676
Other current liabilities		10,027		9,351


Total current liabilities		72,310		69,420
Long-term debt		59,578		66,662
Long-term income taxes		29,432		29,612
Long-term unearned revenue		3,180		4,530
Deferred income taxes		204		233
Operating lease liabilities		7,671		6,188
Other long-term liabilities		10,632		7,581


Total liabilities		183,007		184,226


Commitments and contingencies
Stockholders’ equity:
Common stock and paid-in capital – shares authorized 24,000; outstanding 7,571 and 7,643		80,552		78,520
Retained earnings		34,566		24,150
Accumulated other comprehensive income (loss)		3,186		(340	)


Total stockholders’ equity		118,304		102,330


Total liabilities and stockholders’ equity	$	301,311	$	286,556

Refer to accompanying notes.

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Item 8

CASH FLOWS STATEMENTS

(In millions)


Year Ended June 30,	2020			2019			2018

Operations
Net income	$	44,281		$	39,240		$	16,571
Adjustments to reconcile net income to net cash from operations:
Depreciation, amortization, and other		12,796			11,682			10,261
Stock-based compensation expense		5,289			4,652			3,940
Net recognized gains on investments and derivatives		(219	)		(792	)		(2,212	)
Deferred income taxes		11			(6,463	)		(5,143	)
Changes in operating assets and liabilities:
Accounts receivable		(2,577	)		(2,812	)		(3,862	)
Inventories		168			597			(465	)
Other current assets		(2,330	)		(1,718	)		(952	)
Other long-term assets		(1,037	)		(1,834	)		(285	)
Accounts payable		3,018			232			1,148
Unearned revenue		2,212			4,462			5,922
Income taxes		(3,631	)		2,929			18,183
Other current liabilities		1,346			1,419			798
Other long-term liabilities		1,348			591			(20	)


Net cash from operations		60,675			52,185			43,884


Financing
Repayments of short-term debt, maturities of 90 days or less, net		0			0			(7,324	)
Proceeds from issuance of debt		0			0			7,183
Cash premium on debt exchange		(3,417	)		0			0
Repayments of debt		(5,518	)		(4,000	)		(10,060	)
Common stock issued		1,343			1,142			1,002
Common stock repurchased		(22,968	)		(19,543	)		(10,721	)
Common stock cash dividends paid		(15,137	)		(13,811	)		(12,699	)
Other, net		(334	)		(675	)		(971	)


Net cash used in financing		(46,031	)		(36,887	)		(33,590	)


Investing
Additions to property and equipment		(15,441	)		(13,925	)		(11,632	)
Acquisition of companies, net of cash acquired, and purchases of intangible and other assets		(2,521	)		(2,388	)		(888	)
Purchases of investments		(77,190	)		(57,697	)		(137,380	)
Maturities of investments		66,449			20,043			26,360
Sales of investments		17,721			38,194			117,577
Other, net		(1,241	)		0			(98	)


Net cash used in investing		(12,223	)		(15,773	)		(6,061	)


Effect of foreign exchange rates on cash and cash equivalents		(201	)		(115	)		50


Net change in cash and cash equivalents		2,220			(590	)		4,283
Cash and cash equivalents, beginning of period		11,356			11,946			7,663


Cash and cash equivalents, end of period	$	13,576		$	11,356		$	11,946

Refer to accompanying notes.

PART II

Item 8

STOCKHOLDERS’ EQUITY STATEMENTS

(In millions)


Year Ended June 30,	2020			2019			2018

Common stock and paid-in capital
Balance, beginning of period	$	78,520		$	71,223		$	69,315
Common stock issued		1,343			6,829			1,002
Common stock repurchased		(4,599	)		(4,195	)		(3,033	)
Stock-based compensation expense		5,289			4,652			3,940
Other, net		(1	)		11			(1	)


Balance, end of period		80,552			78,520			71,223


Retained earnings
Balance, beginning of period		24,150			13,682			17,769
Net income		44,281			39,240			16,571
Common stock cash dividends		(15,483	)		(14,103	)		(12,917	)
Common stock repurchased		(18,382	)		(15,346	)		(7,699	)
Cumulative effect of accounting changes		0			677			(42	)


Balance, end of period		34,566			24,150			13,682


Accumulated other comprehensive income (loss)
Balance, beginning of period		(340	)		(2,187	)		627
Other comprehensive income (loss)		3,526			1,914			(2,856	)
Cumulative effect of accounting changes		0			(67	)		42


Balance, end of period		3,186			(340	)		(2,187	)


Total stockholders’ equity	$	118,304		$	102,330		$	82,718


Cash dividends declared per common share	$	2.04		$	1.84		$	1.68

Refer to accompanying notes.

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Item 8

NOTES TO FINANCIAL STATEMENTS

NOTE 1 — ACCOUNTING POLICIES

Accounting Principles

Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements.

Principles of Consolidation

The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated.

Estimates and Assumptions

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (“SSP”) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns; and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from management’s estimates and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to the recent outbreak of a novel strain of the coronavirus (“COVID-19”).

In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years. This change in accounting estimate will be effective beginning fiscal year 2021.

Foreign Currencies

Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income.

Revenue

Product Revenue and Service and Other Revenue

Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.

Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.

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Revenue Recognition

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

Nature of Products and Services

Licenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.

Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (“SA”). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time.

Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided.

Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided.

Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces.

Refer to Note 19 – Segment Information and Geographic Data for further information, including revenue by significant product and service offering.

Significant Judgments

Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.

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Item 8

Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services.

In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP.

Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers.

Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.

Contract Balances

Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses.

As of June 30, 2020 and 2019, long-term accounts receivable, net of allowance for doubtful accounts, was $2.7 billion and $2.2 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.

The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence.

Activity in the allowance for doubtful accounts was as follows:

(In millions)


Year Ended June 30,		2020			2019			2018

Balance, beginning of period	$	434		$	397		$	361
Charged to costs and other		560			153			134
Write-offs		(178	)		(116	)		(98	)


Balance, end of period	$	816		$	434		$	397

Allowance for doubtful accounts included in our consolidated balance sheets:

(In millions)


June 30,		2020		2019		2018

Accounts receivable, net of allowance for doubtful accounts	$	788	$	411	$	377
Other long-term assets		28		23		20


Total	$	816	$	434	$	397

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Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future; LinkedIn subscriptions; Office 365 subscriptions; Xbox Live subscriptions; Windows 10 post-delivery support; Dynamics business solutions; Skype prepaid credits and subscriptions; and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service.

Refer to Note 13 – Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.

We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2020 and 2019, our financing receivables, net were $5.2 billion and $4.3 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.

Assets Recognized from Costs to Obtain a Contract with a Customer

We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets.

We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.

Cost of Revenue

Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by original equipment manufacturers (“OEM”), to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain online products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products.

Product Warranty

We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.

PART II

Item 8

Research and Development

Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products.

Sales and Marketing

Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.6 billion in fiscal years 2020, 2019, and 2018.

Stock-Based Compensation

Compensation cost for stock awards, which include restricted stock units (“RSUs”) and performance stock units (“PSUs”), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.

Compensation expense for the employee stock purchase plan (“ESPP”) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.

Income Taxes

Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets.

Financial Instruments

Investments

We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations.

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Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in other comprehensive income. Debt investments are impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of, and business outlook, for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established.

Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net.

Derivatives

Derivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.

For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in earnings.

For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.

Fair Value Measurements

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

•

Level 1 – inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges.

•

Level 2 – inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts.

PART II

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•

Level 3 – inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, municipal securities, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities.

We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections.

Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.

Inventories

Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years; computer equipment, two to three years; buildings and improvements, five to 15 years; leasehold improvements, three to 20 years; and furniture and equipment, one to 10 years. Land is not depreciated.

Leases

We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities.

Goodwill

Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.

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Intangible Assets

Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired.

Recent Accounting Guidance

Recently Adopted Accounting Guidance

Financial Instruments – Targeted Improvements to Accounting for Hedging Activities

In August 2017, the Financial Accounting Standards Board (“FASB”) issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. We adopted the standard effective July 1, 2019. As we did not hold derivative instruments requiring an adjustment upon adoption, there was no impact in our consolidated financial statements. Adoption of the standard enhanced the presentation of the effects of our hedging instruments and the hedged items in our consolidated financial statements to increase the understandability of the results of our hedging strategies.

Recent Accounting Guidance Not Yet Adopted

Financial Instruments – Credit Losses

In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivable, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We have evaluated the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems. We continue to monitor economic implications of the COVID-19 pandemic. Based on current market conditions, adoption of the standard will not have a material impact on our consolidated financial statements.

Accounting for Income Taxes

In December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021, with early adoption permitted. We are currently evaluating the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems.

NOTE 2 — EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.

PART II

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The components of basic and diluted EPS were as follows:

(In millions, except earnings per share)


Year Ended June 30,	2020		2019		2018

Net income available for common shareholders (A)	$	44,281	$	39,240	$	16,571

Weighted average outstanding shares of common stock (B)		7,610		7,673		7,700
Dilutive effect of stock-based awards		73		80		94


Common stock and common stock equivalents (C)		7,683		7,753		7,794


Earnings Per Share

Basic (A/B)	$	5.82	$	5.11	$	2.15
Diluted (A/C)	$	5.76	$	5.06	$	2.13

Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.

NOTE 3 — OTHER INCOME (EXPENSE), NET

The components of other income (expense), net were as follows:

(In millions)


Year Ended June 30,	2020			2019			2018

Interest and dividends income	$	2,680		$	2,762		$	2,214
Interest expense		(2,591	)		(2,686	)		(2,733	)
Net recognized gains on investments		32			648			2,399
Net gains (losses) on derivatives		187			144			(187	)
Net losses on foreign currency remeasurements		(191	)		(82	)		(218	)
Other, net		(40	)		(57	)		(59	)


Total	$	77		$	729		$	1,416

Net Recognized Gains (Losses) on Investments

Net recognized gains (losses) on debt investments were as follows:

(In millions)


Year Ended June 30,	2020			2019			2018

Realized gains from sales of available-for-sale securities	$	50		$	12		$	27
Realized losses from sales of available-for-sale securities		(37	)		(93	)		(987	)
Other-than-temporary impairments of investments		(17	)		(16	)		(6	)


Total	$	(4	)	$	(97	)	$	(966	)

Net recognized gains (losses) on equity investments were as follows:

(In millions)


Year Ended June 30,	2020			2019			2018

Net realized gains on investments sold	$	83		$	276		$	3,406
Net unrealized gains on investments still held		69			479			0
Impairments of investments		(116	)		(10	)		(41	)


Total	$	36		$	745		$	3,365

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NOTE 4 — INVESTMENTS

Investment Components

The components of investments were as follows:

(In millions)	Fair Value Level		Cost Basis		Unrealized Gains		Unrealized Losses			Recorded Basis		Cash and Cash Equivalents		Short-term Investments		Equity Investments


June 30, 2020

Changes in Fair Value Recorded in Other Comprehensive Income

Commercial paper		Level 2	$	4,687	$	1	$	0		$	4,688	$	1,618	$	3,070	$	0
Certificates of deposit		Level 2		2,898		0		0			2,898		1,646		1,252		0
U.S. government securities		Level 1		92,067		6,495		(1	)		98,561		3,168		95,393		0
U.S. agency securities		Level 2		2,439		2		0			2,441		449		1,992		0
Foreign government bonds		Level 2		6,982		6		(3	)		6,985		1		6,984		0
Mortgage- and asset-backed securities		Level 2		4,865		41		(6	)		4,900		0		4,900		0
Corporate notes and bonds		Level 2		8,500		327		(17	)		8,810		0		8,810		0
Corporate notes and bonds		Level 3		58		0		0			58		0		58		0
Municipal securities		Level 2		313		57		(4	)		366		0		366		0
Municipal securities		Level 3		91		0		0			91		0		91		0


Total debt investments			$	122,900	$	6,929	$	(31	)	$	129,798	$	6,882	$	122,916	$	0


Changes in Fair Value Recorded in Net Income

Equity investments		Level 1								$	1,198	$	784	$	0	$	414
Equity investments		Other									2,551		0		0		2,551


Total equity investments										$	3,749	$	784	$	0	$	2,965


Cash										$	5,910	$	5,910	$	0	$	0
Derivatives, net^(a)											35		0		35		0


Total										$	139,492	$	13,576	$	122,951	$	2,965

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(In millions)	Fair Value Level		Cost Basis		Unrealized Gains		Unrealized Losses			Recorded Basis		Cash and Cash Equivalents		Short-term Investments		Equity Investments


June 30, 2019

Changes in Fair Value Recorded in Other Comprehensive Income

Commercial paper		Level 2	$	2,211	$	0	$	0		$	2,211	$	1,773	$	438	$	0
Certificates of deposit		Level 2		2,018		0		0			2,018		1,430		588		0
U.S. government securities		Level 1		104,925		1,854		(104	)		106,675		769		105,906		0
U.S. agency securities		Level 2		988		0		0			988		698		290		0
Foreign government bonds		Level 2		6,350		4		(8	)		6,346		2,506		3,840		0
Mortgage- and asset-backed securities		Level 2		3,554		10		(3	)		3,561		0		3,561		0
Corporate notes and bonds		Level 2		7,437		111		(7	)		7,541		0		7,541		0
Corporate notes and bonds		Level 3		15		0		0			15		0		15		0
Municipal securities		Level 2		242		48		0			290		0		290		0
Municipal securities		Level 3		7		0		0			7		0		7		0


Total debt investments			$	127,747	$	2,027	$	(122	)	$	129,652	$	7,176	$	122,476	$	0


Changes in Fair Value Recorded in Net Income

Equity investments		Level 1								$	973	$	409	$	0	$	564
Equity investments		Other									2,085		0		0		2,085


Total equity investments										$	3,058	$	409	$	0	$	2,649


Cash										$	3,771	$	3,771	$	0	$	0
Derivatives, net^(a)											(13)		0		(13)		0


Total										$	136,468	$	11,356	$	122,463	$	2,649

(a)	Refer to Note 5 – Derivatives for further information on the fair value of our derivative instruments.

Equity investments presented as “Other” in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2020 and 2019, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.4 billion and $1.2 billion, respectively.

Unrealized Losses on Debt Investments

Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows:

	Less than 12 Months					12 Months or Greater						Total Unrealized Losses


(In millions)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Total Fair Value


June 30, 2020

U.S. government and agency securities	$	2,323	$	(1	)	$	0	$	0	$	2,323	$	(1	)
Foreign government bonds		500		(3	)		0		0		500		(3	)
Mortgage- and asset-backed securities		1,014		(6	)		0		0		1,014		(6	)
Corporate notes and bonds		649		(17	)		0		0		649		(17	)
Municipal securities		66		(4	)		0		0		66		(4	)


Total	$	4,552	$	(31	)	$	0	$	0	$	4,552	$	(31	)

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Item 8

	Less than 12 Months					12 Months or Greater							Total Unrealized Losses


(In millions)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Total Fair Value


June 30, 2019

U.S. government and agency securities	$	1,491	$	(1	)	$	39,158	$	(103	)	$	40,649	$	(104	)
Foreign government bonds		25		0			77		(8	)		102		(8	)
Mortgage- and asset-backed securities		664		(1	)		378		(2	)		1,042		(3	)
Corporate notes and bonds		498		(3	)		376		(4	)		874		(7	)


Total	$	2,678	$	(5	)	$	39,989	$	(117	)	$	42,667	$	(122	)

Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence.

Debt Investment Maturities

(In millions)	Cost Basis		Estimated Fair Value


June 30, 2020

Due in one year or less	$	36,169	$	36,276
Due after one year through five years		51,465		54,700
Due after five years through 10 years		32,299		35,674
Due after 10 years		2,967		3,148


Total	$	122,900	$	129,798

NOTE 5 — DERIVATIVES

We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment.

Foreign Currencies

Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions.

Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.

In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.

Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures.

PART II

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Interest Rate

Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.

Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Equity

Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Credit

Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Credit-Risk-Related Contingent Features

Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2020, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.

The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:

(In millions)	June 30, 2020		June 30, 2019


Designated as Hedging Instruments

Foreign exchange contracts purchased	$	635	$	0
Foreign exchange contracts sold		6,754		6,034
Interest rate contracts purchased		1,295		0

Not Designated as Hedging Instruments

Foreign exchange contracts purchased		11,896		14,889
Foreign exchange contracts sold		15,595		15,614
Other contracts purchased		1,844		2,007
Other contracts sold		757		456

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Item 8

Fair Values of Derivative Instruments

The following table presents our derivative instruments:

	Derivative			Derivative				Derivative				Derivative
(In millions)	Assets			Liabilities				Assets				Liabilities


	June 30, 2020							June 30, 2019

Designated as Hedging Instruments

Foreign exchange contracts	$	44			$	(54	)		$	0			$	(93	)
Interest rate contracts		93				0				0				0

Not Designated as Hedging Instruments

Foreign exchange contracts		245				(334	)			204				(172	)
Other contracts		18				(11	)			46				(7	)


Gross amounts of derivatives		400				(399	)			250				(272	)
Gross amounts of derivatives offset in the balance sheet		(154	)			158				(113	)			114
Cash collateral received		0				(154	)			0				(78	)


Net amounts of derivatives	$	246			$	(395	)		$	137			$	(236	)


Reported as

Short-term investments	$	35			$	0			$	(13	)		$	0
Other current assets		199				0				146				0
Other long-term assets		12				0				4				0
Other current liabilities		0				(334	)			0				(221	)
Other long-term liabilities		0				(61	)			0				(15	)


Total	$	246			$	(395	)		$	137			$	(236	)

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $399 million and $399 million, respectively, as of June 30, 2020, and $247 million and $272 million, respectively, as of June 30, 2019.

The following table presents the fair value of our derivatives instruments on a gross basis:

(In millions)	Level 1			Level 2		Level 3		Total


June 30, 2020

Derivative assets	$	1	$	398		$	1	$	400
Derivative liabilities		0		(399	)		0		(399	)

June 30, 2019

Derivative assets		0		247			3		250
Derivative liabilities		0		(272	)		0		(272	)

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Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows:

(In millions)


Year Ended June 30,	2020					2019						2018

	Revenue		Other Income (Expense), Net				Revenue			Other Income (Expense), Net			Revenue			Other Income (Expense), Net


Designated as Fair Value Hedging Instruments

Foreign exchange contracts
Derivatives	$	0	$	1			$	0		$	(130	)	$	0		$	(78	)
Hedged items		0		3				0			130			0			78
Excluded from effectiveness assessment		0		139				0			168			0			103
Interest rate contracts
Derivatives		0		93				0			0			0			0
Hedged items		0		(93	)			0			0			0			0
Equity contracts
Derivatives		0		0				0			0			0			(324	)
Hedged items		0		0				0			0			0			324
Excluded from effectiveness assessment		0		0				0			0			0			80

Designated as Cash Flow Hedging Instruments

Foreign exchange contracts
Amount reclassified from accumulated other comprehensive income		0		0				341			0			185			0
Excluded from effectiveness assessment		0		0				(64	)		0			(255	)		0

Not Designated as Hedging Instruments

Foreign exchange contracts		0		(123	)			0			(97	)		0			(33	)
Other contracts		0		50				0			38			0			(104	)

Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:

(In millions)


Year Ended June 30,	2020			2019		2018

Designated as Cash Flow Hedging Instruments

Foreign exchange contracts
Included in effectiveness assessment	$	(38	)	$	159	$	219

NOTE 6 — INVENTORIES

The components of inventories were as follows:

(In millions)


June 30,	2020		2019

Raw materials	$	700	$	399
Work in process		83		53
Finished goods		1,112		1,611


Total	$	1,895	$	2,063

PART II

Item 8

NOTE 7 — PROPERTY AND EQUIPMENT

The components of property and equipment were as follows:

(In millions)


June 30,	2020			2019

Land	$	1,823		$	1,540
Buildings and improvements		33,995			26,288
Leasehold improvements		5,487			5,316
Computer equipment and software		41,261			33,823
Furniture and equipment		4,782			4,840


Total, at cost		87,348			71,807
Accumulated depreciation		(43,197	)		(35,330	)


Total, net	$	44,151		$	36,477

During fiscal years 2020, 2019, and 2018, depreciation expense was $10.7 billion, $9.7 billion, and $7.7 billion, respectively. We have committed $5.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2020.

During fiscal year 2020, we recorded an impairment charge of $186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsoft Store physical locations.

NOTE 8 — BUSINESS COMBINATIONS

GitHub, Inc.

On October 25, 2018, we acquired GitHub, Inc. (“GitHub”), a software development platform, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsoft’s developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.

The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows:

(In millions)


Cash, cash equivalents, and short-term investments	$	234
Goodwill		5,497
Intangible assets		1,267
Other assets		143
Other liabilities		(217	)


Total	$	6,924

The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment.

PART II

Item 8

Following are the details of the purchase price allocated to the intangible assets acquired:

(In millions)	Amount		Weighted Average Life


Customer-related	$	648		8 years
Technology-based		447		5 years
Marketing-related		170		10 years
Contract-based		2		2 years


Total	$	1,267		7 years

Transactions recognized separately from the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period.

Other

During fiscal year 2020, we completed 15 acquisitions for $2.4 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. The effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.

NOTE 9 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

(In millions)		June 30, 2018		Acquisitions			Other			June 30, 2019		Acquisitions		Other			June 30, 2020


Productivity and Business Processes	$	23,823	$	514		$	(60	)	$	24,277	$	7	$	(94	)	$	24,190
Intelligent Cloud		5,703		5,605	^(a)		43	^(a)		11,351		1,351		(5	)		12,697
More Personal Computing		6,157		289			(48	)		6,398		96		(30	)		6,464


Total	$	35,683	$	6,408		$	(65	)	$	42,026	$	1,454	$	(129	)	$	43,351

(a)	Includes goodwill of $5.5 billion related to GitHub. See Note 8 – Business Combinations for further information.

The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined.

Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as “Other” in the table above. Also included in “Other” are business dispositions and transfers between segments due to reorganizations, as applicable.

Goodwill Impairment

We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses.

No instances of impairment were identified in our May 1, 2020, May 1, 2019, or May 1, 2018 tests. As of June 30, 2020 and 2019, accumulated goodwill impairment was $11.3 billion.

PART II

Item 8

NOTE 10 — INTANGIBLE ASSETS

The components of intangible assets, all of which are finite-lived, were as follows:

(In millions)	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount


June 30,						2020								2019

Technology-based	$	8,160	$	(6,381	)	$	1,779	$	7,691		$	(5,771	)	$	1,920
Customer-related		4,967		(2,320	)		2,647		4,709			(1,785	)		2,924
Marketing-related		4,158		(1,588	)		2,570		4,165			(1,327	)		2,838
Contract-based		474		(432	)		42		574			(506	)		68


Total	$	17,759	$	(10,721	)	$	7,038	$	17,139	^(a)	$	(9,389	)	$	7,750

(a)	Includes intangible assets of $1.3 billion related to GitHub. See Note 8 – Business Combinations for further information.

No material impairments of intangible assets were identified during fiscal years 2020, 2019, or 2018. We estimate that we have no significant residual value related to our intangible assets.

The components of intangible assets acquired during the periods presented were as follows:

(In millions)	Amount		Weighted Average Life		Amount		Weighted Average Life


Year Ended June 30,	2020				2019

Technology-based	$	531		6 years	$	814		5 years
Customer-related		303		5 years		710		8 years
Marketing-related		2		2 years		177		10 years
Contract-based		0		0 years		7		3 years


Total	$	836		5 years	$	1,708		7 years

Intangible assets amortization expense was $1.6 billion, $1.9 billion, and $2.2 billion for fiscal years 2020, 2019, and 2018, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2020:

(In millions)


Year Ending June 30,

2021	$	1,483
2022		1,399
2023		1,219
2024		851
2025		447
Thereafter		1,639


Total	$	7,038

PART II

Item 8

NOTE 11 — DEBT

The components of debt were as follows:

(In millions, issuance by calendar year)	Maturities (calendar year)				Stated Interest Rate				Effective Interest Rate			June 30, 2020				June 30, 2019


2009 issuance of $3.8 billion ^(a)				2039				5.20%			5.24%		$	559		$	750
2010 issuance of $4.8 billion ^(a)		2020	–	2040		3.00%	–	4.50%	3.14%	–	4.57%			1,571			2,000
2011 issuance of $2.3 billion ^(a)		2021	–	2041		4.00%	–	5.30%	4.08%	–	5.36%			1,270			1,500
2012 issuance of $2.3 billion		2022	–	2042		2.13%	–	3.50%	2.24%	–	3.57%			1,650			1,650
2013 issuance of $5.2 billion ^(a)		2023	–	2043		2.38%	–	4.88%	2.47%	–	4.92%			2,919			3,500
2013 issuance of €4.1 billion		2021	–	2033		2.13%	–	3.13%	2.23%	–	3.22%			4,549			4,613
2014 issuance														0			18
2015 issuance of $23.8 billion ^(a)		2020	–	2055		2.00%	–	4.75%	2.09%	–	4.78%			15,549			22,000
2016 issuance of $19.8 billion ^(a)		2021	–	2056		1.55%	–	3.95%	1.64%	–	4.03%			16,955			19,750
2017 issuance of $17.0 billion ^(a)		2022	–	2057		2.40%	–	4.50%	2.52%	–	4.53%			12,385			17,000
2020 issuance of $10.0 billion ^(a)		2050	–	2060		2.53%	–	2.68%	2.53%	–	2.68%			10,000			0


Total face value														67,407			72,781
Unamortized discount and issuance costs														(554	)		(603	)
Hedge fair value adjustments ⁽^b⁾														93			0
Premium on debt exchange ^(a)														(3,619	)		0


Total debt														63,327			72,178
Current portion of long-term debt														(3,749	)		(5,516	)


Long-term debt													$	59,578		$	66,662

(a)	In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities. The premium will be amortized over the term of the new debt.

(b)	Refer to Note 5 – Derivatives for further information on the interest rate swaps related to fixed-rate debt.

As of June 30, 2020 and 2019, the estimated fair value of long-term debt, including the current portion, was $77.1 billion and $78.9 billion, respectively. The estimated fair values are based on Level 2 inputs.

Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually.

The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2020:

(In millions)


Year Ending June 30,

2021	$	3,750
2022		7,966
2023		2,750
2024		5,250
2025		2,250
Thereafter		45,441


Total	$	67,407

PART II

Item 8

NOTE 12 — INCOME TAXES

Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $13.7 billion related to the enactment of the TCJA in fiscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118.

In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income (“GILTI”) tax.

Provision for Income Taxes

The components of the provision for income taxes were as follows:

(In millions)


Year Ended June 30,	2020			2019			2018

Current Taxes

U.S. federal	$	3,537		$	4,718		$	19,764
U.S. state and local		763			662			934
Foreign		4,444			5,531			4,348


Current taxes	$	8,744		$	10,911		$	25,046

Deferred Taxes

U.S. federal	$	58		$	(5,647	)	$	(4,292	)
U.S. state and local		(6	)		(1,010	)		(458	)
Foreign		(41	)		194			(393	)


Deferred taxes	$	11		$	(6,463	)	$	(5,143	)


Provision for income taxes	$	8,755		$	4,448		$	19,903

U.S. and foreign components of income before income taxes were as follows:

(In millions)


Year Ended June 30,	2020		2019		2018

U.S.	$	24,116	$	15,799	$	11,527
Foreign		28,920		27,889		24,947


Income before income taxes	$	53,036	$	43,688	$	36,474

PART II

Item 8

Effective Tax Rate

The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows:



Year Ended June 30,	2020		2019		2018

Federal statutory rate		21.0%		21.0%		28.1%
Effect of:
Foreign earnings taxed at lower rates		(3.7)%		(4.1)%		(7.8)%
Impact of the enactment of the TCJA		0%		0.4%		37.7%
Impact of intangible property transfers		0%		(5.9)%		0%
Foreign-derived intangible income deduction		(1.1)%		(1.4)%		0%
State income taxes, net of federal benefit		1.3%		0.7%		1.3%
Research and development credit		(1.1)%		(1.1)%		(1.3)%
Excess tax benefits relating to stock-based compensation		(2.2)%		(2.2)%		(2.5)%
Interest, net		1.0%		1.0%		1.2%
Other reconciling items, net		1.3%		1.8%		(2.1)%


Effective rate		16.5%		10.2%		54.6%

The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $2.6 billion net income tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, offset in part by earnings taxed at lower rates in foreign jurisdictions. In fiscal year 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 86% of our foreign income before tax. In fiscal years 2019 and 2018, our foreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82% and 87% of our foreign income before tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax. In fiscal years 2020, 2019, and 2018, there were no individually significant other reconciling items.

The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers.

PART II

Item 8

The components of the deferred income tax assets and liabilities were as follows:

(In millions)


June 30,	2020			2019

Deferred Income Tax Assets

Stock-based compensation expense	$	461		$	406
Accruals, reserves, and other expenses		2,721			2,287
Loss and credit carryforwards		865			3,518
Depreciation and amortization		6,361			7,046
Leasing liabilities		3,025			1,594
Unearned revenue		1,553			475
Other		354			367


Deferred income tax assets		15,340			15,693
Less valuation allowance		(755	)		(3,214	)


Deferred income tax assets, net of valuation allowance	$	14,585		$	12,479


Deferred Income Tax Liabilities

Book/tax basis differences in investments and debt	$	(2,642	)	$	(738	)
Unearned revenue		0			(30	)
Leasing assets		(2,817	)		(1,510	)
Deferred GILTI tax liabilities		(2,581	)		(2,607	)
Other		(344	)		(291	)


Deferred income tax liabilities	$	(8,384	)	$	(5,176	)


Net deferred income tax assets	$	6,201		$	7,303


Reported As

Other long-term assets	$	6,405		$	7,536
Long-term deferred income tax liabilities		(204	)		(233	)


Net deferred income tax assets	$	6,201		$	7,303

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered.

As of June 30, 2020, we had federal, state, and foreign net operating loss carryforwards of $547 million, $975 million, and $2.0 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2021 through 2040, if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance.

The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. In fiscal year 2020, we removed $2.0 billion of foreign net operating losses and corresponding valuation allowances as a result of the liquidation of a foreign subsidiary. There was no impact to our consolidated financial statements.

Income taxes paid, net of refunds, were $12.5 billion, $8.4 billion, and $5.5 billion in fiscal years 2020, 2019, and 2018, respectively.

Uncertain Tax Positions

Gross unrecognized tax benefits related to uncertain tax positions as of June 30, 2020, 2019, and 2018, were $13.8 billion, $13.1 billion, and $12.0 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2020, 2019, and 2018 by $12.1 billion, $12.0 billion, and $11.3 billion, respectively.

PART II

Item 8

As of June 30, 2020, 2019, and 2018, we had accrued interest expense related to uncertain tax positions of $4.0 billion, $3.4 billion, and $3.0 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2020, 2019, and 2018 included interest expense related to uncertain tax positions of $579 million, $515 million, and $688 million, respectively, net of income tax benefits.

The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:

(In millions)


Year Ended June 30,	2020			2019			2018

Beginning unrecognized tax benefits	$	13,146		$	11,961		$	11,737
Decreases related to settlements		(31	)		(316	)		(193	)
Increases for tax positions related to the current year		647			2,106			1,445
Increases for tax positions related to prior years		366			508			151
Decreases for tax positions related to prior years		(331	)		(1,113	)		(1,176	)
Decreases due to lapsed statutes of limitations		(5	)		0			(3	)


Ending unrecognized tax benefits	$	13,792		$	13,146		$	11,961

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. In April 2020, the IRS commenced the audit for tax years 2014 to 2017.

As of June 30, 2020, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.

We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.

NOTE 13 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

(In millions)


June 30,	2020		2019

Productivity and Business Processes	$	18,643	$	16,831
Intelligent Cloud		16,620		16,988
More Personal Computing		3,917		3,387


Total	$	39,180	$	37,206

Changes in unearned revenue were as follows:

(In millions)


Year Ended June 30, 2020

Balance, beginning of period	$	37,206
Deferral of revenue		78,922
Recognition of unearned revenue		(76,948	)


Balance, end of period	$	39,180

PART II

Item 8

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $111 billion as of June 30, 2020, of which $107 billion is related to the commercial portion of revenue. We expect to recognize approximately 50% of this revenue over the next 12 months and the remainder thereafter.

NOTE 14 — LEASES

We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year.

The components of lease expense were as follows:

(In millions)


Year Ended June 30,	2020			2019		2018

Operating lease cost	$	2,043	$	1,707	$	1,585


Finance lease cost:
Amortization of right-of-use assets	$	611	$	370	$	243
Interest on lease liabilities		336		247		175


Total finance lease cost	$	947	$	617	$	418

Supplemental cash flow information related to leases was as follows:

(In millions)


Year Ended June 30,	2020			2019		2018

Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	1,829	$	1,670	$	1,522
Operating cash flows from finance leases		336		247		175
Financing cash flows from finance leases		409		221		144

Right-of-use assets obtained in exchange for lease obligations:
Operating leases		3,677		2,303		1,571
Finance leases		3,467		2,532		1,933

PART II

Item 8

Supplemental balance sheet information related to leases was as follows:

(In millions, except lease term and discount rate)


June 30,	2020			2019

Operating Leases

Operating lease right-of-use assets	$	8,753		$	7,379


Other current liabilities	$	1,616		$	1,515
Operating lease liabilities		7,671			6,188


Total operating lease liabilities	$	9,287		$	7,703


Finance Leases

Property and equipment, at cost	$	10,371		$	7,041
Accumulated depreciation		(1,385	)		(774	)


Property and equipment, net	$	8,986		$	6,267


Other current liabilities	$	540		$	317
Other long-term liabilities		8,956			6,257


Total finance lease liabilities	$	9,496		$	6,574


Weighted Average Remaining Lease Term

Operating leases		8 years			7 years
Finance leases		13 years			13 years

Weighted Average Discount Rate

Operating leases		2.7%			3.0%
Finance leases		3.9%			4.6%

Maturities of lease liabilities were as follows:

(In millions)


Year Ending June 30,	Operating Leases			Finance Leases

2021	$	1,807		$	880
2022		1,652			894
2023		1,474			903
2024		1,262			916
2025		1,000			1,236
Thereafter		3,122			7,194


Total lease payments		10,317			12,023
Less imputed interest		(1,030	)		(2,527	)


Total	$	9,287		$	9,496

As of June 30, 2020, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $3.4 billion and $3.5 billion, respectively. These operating and finance leases will commence between fiscal year 2021 and fiscal year 2023 with lease terms of 1 year to 16 years.

During fiscal year 2020, we recorded an impairment charge of $161 million to operating lease right-of-use assets due to the closing of our Microsoft Store physical locations.

PART II

Item 8

NOTE 15 — CONTINGENCIES

Patent and Intellectual Property Claims

There were 64 patent infringement cases pending against Microsoft as of June 30, 2020, none of which are material individually or in aggregate.

Antitrust, Unfair Competition, and Overcharge Class Actions

Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010.

The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence once each court approves the form of notice to the class.

Other Antitrust Litigation and Claims

China State Administration for Industry and Commerce Investigation

In 2014, Microsoft was informed that China’s State Agency for Market Regulation (“SAMR”) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to China’s Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.

Product-Related Litigation

U.S. Cell Phone Litigation

Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokia’s Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (“FCC Guidelines”) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines.

In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs’ expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants’ motion to exclude the plaintiffs’ general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs’ expert reports. A hearing is expected to occur in the second quarter of fiscal year 2021.

PART II

Item 8

Other Contingencies

We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future.

As of June 30, 2020, we accrued aggregate legal liabilities of $306 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable.

NOTE 16 — STOCKHOLDERS’ EQUITY

Shares Outstanding

Shares of common stock outstanding were as follows:

(In millions)


Year Ended June 30,	2020			2019			2018

Balance, beginning of year		7,643			7,677			7,708
Issued		54			116			68
Repurchased		(126	)		(150	)		(99	)


Balance, end of year		7,571			7,643			7,677

Share Repurchases

On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020.

On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in February 2020, following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2020, $31.7 billion remained of this $40.0 billion share repurchase program.

PART II

Item 8

We repurchased the following shares of common stock under the share repurchase programs:

(In millions)	Shares		Amount		Shares		Amount		Shares		Amount


Year Ended June 30,	2020				2019				2018

First Quarter		29	$	4,000		24	$	2,600		22	$	1,600
Second Quarter		32		4,600		57		6,100		22		1,800
Third Quarter		37		6,000		36		3,899		34		3,100
Fourth Quarter		28		5,088		33		4,200		21		2,100


Total		126	$	19,688		150	$	16,799		99	$	8,600

Shares repurchased during the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $3.3 billion, $2.7 billion, and $2.1 billion for fiscal years 2020, 2019, and 2018, respectively. All share repurchases were made using cash resources.

Dividends

Our Board of Directors declared the following dividends:

Declaration Date	Record Date		Payment Date		Dividend Per Share			Amount


Fiscal Year 2020								(In millions)

September 18, 2019		November 21, 2019		December 12, 2019		$	0.51	$	3,886
December 4, 2019		February 20, 2020		March 12, 2020			0.51		3,876
March 9, 2020		May 21, 2020		June 11, 2020			0.51		3,865
June 17, 2020		August 20, 2020		September 10, 2020			0.51		3,861


Total						$	2.04	$	15,488

Fiscal Year 2019

September 18, 2018		November 15, 2018		December 13, 2018		$	0.46	$	3,544
November 28, 2018		February 21, 2019		March 14, 2019			0.46		3,526
March 11, 2019		May 16, 2019		June 13, 2019			0.46		3,521
June 12, 2019		August 15, 2019		September 12, 2019			0.46		3,510


Total						$	1.84	$	14,101

The dividend declared on June 17, 2020 was included in other current liabilities as of June 30, 2020.

PART II

Item 8

NOTE 17 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes in accumulated other comprehensive income (loss) by component:

(In millions)


Year Ended June 30,	2020			2019			2018

Derivatives

Balance, beginning of period	$	0		$	173		$	134
Unrealized gains (losses), net of tax of $(10), $2, and $11		(38	)		160			218
Reclassification adjustments for gains included in revenue		0			(341	)		(185	)
Tax expense included in provision for income taxes		0			8			6


Amounts reclassified from accumulated other comprehensive income (loss)		0			(333	)		(179	)


Net change related to derivatives, net of tax of $(10), $(6), and $5		(38	)		(173	)		39


Balance, end of period	$	(38	)	$	0		$	173


Investments

Balance, beginning of period	$	1,488		$	(850	)	$	1,825
Unrealized gains (losses), net of tax of $1,057, $616, and $(427)		3,987			2,331			(1,146	)
Reclassification adjustments for (gains) losses included in other income (expense), net		4			93			(2,309	)
Tax expense (benefit) included in provision for income taxes		(1	)		(19	)		738


Amounts reclassified from accumulated other comprehensive income (loss)		3			74			(1,571	)


Net change related to investments, net of tax of $1,058, $635, and $(1,165)		3,990			2,405			(2,717	)
Cumulative effect of accounting changes		0			(67	)		42


Balance, end of period	$	5,478		$	1,488		$	(850	)


Translation Adjustments and Other

Balance, beginning of period	$	(1,828	)	$	(1,510	)	$	(1,332	)
Translation adjustments and other, net of tax effects of $1, $(1), and $0		(426	)		(318	)		(178	)


Balance, end of period	$	(2,254	)	$	(1,828	)	$	(1,510	)


Accumulated other comprehensive income (loss), end of period	$	3,186		$	(340	)	$	(2,187	)

NOTE 18 — EMPLOYEE STOCK AND SAVINGS PLANS

We grant stock-based compensation to employees and directors. As of June 30, 2020, an aggregate of 283 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.

Stock-based compensation expense and related income tax benefits were as follows:

(In millions)


Year Ended June 30,	2020		2019		2018

Stock-based compensation expense	$	5,289	$	4,652	$	3,940
Income tax benefits related to stock-based compensation		938		816		823

Stock Plans

Stock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years.

PART II

Item 8

Executive Incentive Plan

Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years. PSUs generally vest over a performance period of three years. The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.

Activity for All Stock Plans

The fair value of stock awards was estimated on the date of grant using the following assumptions:



Year ended June 30,				2020				2019				2018

Dividends per share (quarterly amounts)	$	0.46	–	0.51	$	0.42	–	0.46	$	0.39	–	0.42
Interest rates		0.1%	–	2.2%		1.8%	–	3.1%		1.7%	–	2.9%

During fiscal year 2020, the following activity occurred under our stock plans:

Shares			Weighted Average Grant-Date Fair Value


(In millions)

Stock Awards

Nonvested balance, beginning of year	147		$	78.49
Granted ^(a)	53			140.49
Vested	(65	)		75.35
Forfeited	(9	)		90.30


Nonvested balance, end of year	126		$	105.23

(a)	Includes 2 million, 2 million, and 3 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2020, 2019, and 2018, respectively.

As of June 30, 2020, there was approximately $10.2 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years. The weighted average grant-date fair value of stock awards granted was $140.49, $107.02, and $75.88 for fiscal years 2020, 2019, and 2018, respectively. The fair value of stock awards vested was $10.1 billion, $8.7 billion, and $6.6 billion, for fiscal years 2020, 2019, and 2018, respectively.

Employee Stock Purchase Plan

We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. Employees purchased the following shares during the periods presented:

(Shares in millions)


Year Ended June 30,	2020		2019		2018

Shares purchased		9		11		13
Average price per share	$	142.22	$	104.85	$	76.40

As of June 30, 2020, 96 million shares of our common stock were reserved for future issuance through the ESPP.

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Item 8

Savings Plan

We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50% of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $1.0 billion, $877 million, and $807 million in fiscal years 2020, 2019, and 2018, respectively, and were expensed as contributed.

NOTE 19 — SEGMENT INFORMATION AND GEOGRAPHIC DATA

In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

Our reportable segments are described below.

Productivity and Business Processes

Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

•

Office Commercial, including Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (“CALs”).

•

Office Consumer, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive.

•

LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions.

•

Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.

Intelligent Cloud

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises:

•

Server products and cloud services, including Azure; SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub.

•

Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

More Personal Computing

Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises:

•

Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things; and MSN advertising.

•

Devices, including Surface and PC accessories.

PART II

Item 8

•

Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties.

•

Search.

Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin.

In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments.

Segment revenue and operating income were as follows during the periods presented:

(In millions)


Year Ended June 30,		2020		2019		2018

Revenue

Productivity and Business Processes	$	46,398	$	41,160	$	35,865
Intelligent Cloud		48,366		38,985		32,219
More Personal Computing		48,251		45,698		42,276


Total	$	143,015	$	125,843	$	110,360


Operating Income

Productivity and Business Processes	$	18,724	$	16,219	$	12,924
Intelligent Cloud		18,324		13,920		11,524
More Personal Computing		15,911		12,820		10,610


Total	$	52,959	$	42,959	$	35,058

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2020, 2019, or 2018. Revenue, classified by the major geographic areas in which our customers were located, was as follows:

(In millions)


Year Ended June 30,	2020		2019		2018

United States ^(a)	$	73,160	$	64,199	$	55,926
Other countries		69,855		61,644		54,434


Total	$	143,015	$	125,843	$	110,360

(a)	Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue.

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Item 8

Revenue from external customers, classified by significant product and service offerings, was as follows:

(In millions)


Year Ended June 30,	2020		2019		2018

Server products and cloud services	$	41,379	$	32,622	$	26,129
Office products and cloud services		35,316		31,769		28,316
Windows		22,294		20,395		19,518
Gaming		11,575		11,386		10,353
LinkedIn		8,077		6,754		5,259
Search advertising		7,740		7,628		7,012
Devices		6,457		6,095		5,134
Enterprise Services		6,409		6,124		5,846
Other		3,768		3,070		2,793


Total	$	143,015	$	125,843	$	110,360

Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $51.7 billion, $38.1 billion and $26.6 billion in fiscal years 2020, 2019, and 2018, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.

Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.

Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows:

(In millions)


June 30,	2020		2019		2018

United States	$	60,789	$	55,252	$	44,501
Ireland		12,734		12,958		12,843
Other countries		29,770		25,422		22,538


Total	$	103,293	$	93,632	$	79,882

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Item 8

NOTE 20 — QUARTERLY INFORMATION (UNAUDITED)

(In millions, except per share amounts)


Quarter Ended	September 30		December 31		March 31		June 30		Total

Fiscal Year 2020

Revenue	$	33,055	$	36,906	$	35,021	$	38,033	$	143,015
Gross margin		22,649		24,548		24,046		25,694		96,937
Operating income		12,686		13,891		12,975		13,407		52,959
Net income		10,678		11,649		10,752		11,202		44,281
Basic earnings per share		1.40		1.53		1.41		1.48		5.82
Diluted earnings per share		1.38		1.51		1.40		1.46		5.76

Fiscal Year 2019

Revenue		29,084		32,471		30,571		33,717		125,843
Gross margin		19,179		20,048		20,401		23,305		82,933
Operating income		9,955		10,258		10,341		12,405		42,959
Net income ^(a)		8,824		8,420		8,809		13,187		39,240
Basic earnings per share		1.15		1.09		1.15		1.72		5.11
Diluted earnings per share ^(b)		1.14		1.08		1.14		1.71		5.06

(a)

Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 – Income Taxes for further information.

(b)	Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019.

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Item 8

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the "Company") as of June 30, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2020, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 30, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

PART II

Item 8

Revenue Recognition – Refer to Note 1 to the financial statements

Critical Audit Matter Description

The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.

Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following:

•

Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services.

•

The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation.

•

Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services).

•

Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately.

Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.

How the Critical Audit Matter Was Addressed in the Audit

Our principal audit procedures related to the Company's revenue recognition for these customer agreements included the following:

•

We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration.

•

We evaluated management's significant accounting policies related to these customer agreements for reasonableness.

•

We selected a sample of customer agreements and performed the following procedures:

–

Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.

–

Tested management's identification and treatment of contract terms.

–

Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions.

•

We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately.

•

We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements.

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Item 8

Income Taxes – Uncertain Tax Positions – Refer to Note 12 to the financial statements

Critical Audit Matter Description

The Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service ("IRS"). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements.

Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.

How the Critical Audit Matter Was Addressed in the Audit

Our principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following:

•

We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls.

•

We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions.

•

We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions.

•

For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions.

•

We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments.

/s/ DELOITTE & TOUCHE LLP

Seattle, Washington

July 30, 2020

We have served as the Company's auditor since 1983.

PART II

Item 9, 9A